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Blockchain and the capital markets

by Raja Palaniappan on 28 April, 2017 in finance

Blockchain and the capital markets

“Are you guys putting Origin on the Blockchain?”

It’s a question we get almost weekly. While I can still remember the initial scepticism / excitement amongst trading floor friends surrounding the first Bitcoin bubble 4 years ago, these days the word “Blockchain” is everywhere. Its rising popularity seems inexorable, and, especially for those of us in fintech, its adoption is apparently inevitable.

Today, we take a look at what blockchain’s impact could be and when it will occur. Before we look forward, let’s look back at its origins.

The ‘blockchain’ is a digital ledger distributed across computers around the world.

The first public blockchain was engineered in 2009 to support the crypto-currency, Bitcoin. To be verified, each Bitcoin solves encrypted and computationally intensive puzzles. Blockchain is the technology that records this process.

Blockchain is designed to make transactions and records transparent and secure. As people realised its value, uses extended beyond managing crypto-currencies. Blockchain 2.0 arrived in 2014, offering a broader range of services.

Investment in blockchain between 2014 and 2015 doubled. Start-ups appeared that used blockchain to target inefficiencies in finance, especially in trading and settlement. This led to an increase in investment over the past 24 months, with forward-thinking financial services firms exploring ways to process transactions, settlements and implement digital currencies with blockchain.

Here are five areas where participants hope for blockchain to have a significant impact on financial markets:

Distributed Ledger Technology (DLT)

The most impactful advancement will be the adoption of distributed ledger technology (DLT), removing inefficiencies inherent in today’s market infrastructure.

DLT locally records any action taken by participants, then updates the central blockchain in real time, with all participants informed and their actions verified. As it happens on a real time basis, it makes data management and record keeping far more efficient, with a transaction snapshot being available on one system to all participants. This massively reduces friction, time and cost.

More on the background of DLT and its implementation can be found here.

Settlement and clearing

Implementation of DLT will lead to efficient settlement of transactions, as participants see the same data and updates are automatically circulated.

DLT functionality includes centrally stored, online, smart contracts, which would replace the thousands of paper contracts that circulate in the capital markets today.

Smart contracts are created using code, which executes actions agreed by participants. A smart contract would typically be maintained on DLT reducing communications and cost.

Asset servicing

DLT will soon be used to process everyday financial administrative tasks and responsibilities, such as issuance, corporate actions, proxy votes, and portfolio administration.

What has previously involved numerous systems, records and legal admin can be migrated to the blockchain, handled by DLT, with smart contracts ensuring efficient processing.

Reporting and Reconciliation

Reporting and reconciliation of balances and transactions between counter parties will be eliminated. Blockchain allows for balances to be available in real time so reports and reconciliations will be priced and reconciled up-to-the-minute. Regulatory reporting can also be done on this basis.

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Blockchain hasn’t broken into the capital markets mainstream just yet. But its successful integration could lead to massive cost savings. Goldman Sachs projects blockchain could streamline the clearing and settlement of cash securities, saving $2bn in the US and $6bn globally on an annual basis.

But, as with any great technology, we believe that Amara’s law firmly applies to Blockchain. While we may be overestimating the impact of technology in the short term, we are likely underestimating its effect in the long term.